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What is an annuity?

An annuity is a contract between you and an insurance company. You pay either a single premium or make payments for a set period of time in exchange for a regular income.

People often buy annuities with retirement in mind, because they provide a guaranteed income as long as you live.

Types of annuities

There are three different kinds of annuities: fixed, variable, and indexed.

You can buy an annuity by paying one single premium or by making flexible premium payments over a longer period of time. The payouts from most annuities start 10 to 15 years after you buy it. If you pay a single premium upfront, you may have the option to receive income payments within a year.

• Fixed annuities - With a fixed annuity, your money-minus any applicable charges-earns interest at rates set by the insurer as specified in the annuity contract. You can make a single premium payment or flexible premium payments.

• Variable annuities - Under a variable annuity, the insurer invests your money-minus any applicable charges-in a separate account. The company invests your money in stocks, bonds, or other investment funds you choose based upon your risk tolerance.

  If the fund does not do well, you may lose some or all of your investment. You can make a single premium payment or flexible premium payments. Agents and brokers who sell variable annuities must be registered with the Department of Financial Instititutions.

• Equity-indexed annuities - An equity-indexed annuity is a long-term investment contract between you and an insurer. It offers a guaranteed minimum return, plus it offers a variable rate based on the return of a specific index. During the accumulation period, the insurance company credits you with a return based on changes in that index, subject to participation rates, caps, charges, and other restrictions.

  The most commonly used index is Standard & Poor’s 500 Composite Stock Price Index (S&P 500). After the accumulation period, the insurance company makes periodic payments to you per the contract, unless you choose to receive a lump sum. For this annuity, you can make a single premium payment or flexible premium payments.

Benefits of annuities

Annuities provide three main benefits:

• Death benefits - The basic death benefit offers a guarantee that when you die, the insurance company at a minimum will pay out the amount you paid in.
• Living benefits - A living benefit may provide for a minimum guaranteed return, or a minimum lifetime withdrawal amount.
• Tax Deferral - You are not taxed on any interest, dividends or capital gains that accumulate inside of your annuity contract until such time as you take a withdrawal. Capital gains are withdrawn first, and are taxed as ordinary income. Withdrawing capital gains prior to age 59-1/2 may be subject to an additional 10 percent penalty tax.

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